What is a Closed Corporation?
The term “closed corporation” refers to the type of company whose shareholding resides with a few selected individuals who are involved in the core business operations. This type of company is exempted from many requirements that are applicable to other corporations, such as having a board of directors (BoD). Closed corporations are state-specific statutory entities, and many states don’t allow this type of company. Some of the other terms used for this corporate business structure include private company, privately held company, family corporation, close corporation, an incorporated partnership.
Example of Closed Corporation
There are many closed corporations operating across the world, and they are engaged in a wide range of businesses, right from retail to manufacturing to services. According to Forbes’s 2020 rankings, Koch Industries is the largest (by revenue) private company in the US. Let us look at the four largest private companies that are featured in the list.
- Founded in 1940, Koch Industries has interests in multiple industries that cover trading, manufacturing, and investing. The company has a workforce of 120k employees, and it booked revenue of $115 billion in the year ending December 31, 2019.
- Headquartered in Minnesota, Cargill Inc. is primarily engaged in the purchase and distribution of agricultural commodities. The company was founded in 1865 as a grain storage facility. The company has a workforce of 155k employees, and it booked revenue of $114.6 billion in the year ending May 30, 2020.
- Founded in 1845, Deloitte is a financial services company based out of New York, and it delivers business services related to audit, tax, advisory, and consulting. The company has a workforce of 330k employees, and it booked revenue of $47.6 billion in the year ending May 30, 2020.
- Based out of New York, PricewaterhouseCoopers (PwC) is a professional services firm offering assurance, tax, and consulting services. PwC was founded in the year 1998. The company has a workforce of 276k employees, and it booked revenue of $43 billion in the year ending June 29, 2020.
Some of the other companies featured in the top 10 list are Publix Super Markets, Ernst & Young (EY), Mars, Reyes Holdings, H-E-B, and Pilot Flying J.
Dispute Resolution for Closed Corporation
In a closed corporation, any major business decisions have to be approved by most of the shareholders, which is one of the biggest drawbacks of this business structure. The terms of the shareholder agreement must be made in unison, or nothing in it can be altered. This shareholder dispute can be resolved either by incorporating some changes in the shareholder agreement, or the discordant shareholder can take the matter to court. However, the latter step is avoided as far as possible unless and until there are some extreme circumstances where some of the shareholders feel that someone isn’t working in the company’s best interest.
Taxation Issues of Closed Corporation
Any business owner who is planning to start as a closed corporation should be aware of its applicable taxation. Its taxation is different from that of other types of corporations. Further, the taxation can also vary significantly from one state to another. A closed corporation is taxed as a C corporation unless the shareholders or the business owners request IRS for S corporation status. In the case of a C corporation, the company’s income is subject to double taxation, i.e. at the company level and personal level.
Advantages of Closed Corporation
Some of the major advantages are as follows:
- A closed corporation requires fewer formalities than other corporations, which significantly reduces the risk of non-compliance.
- The shareholders of a closed corporation command greater control over the sale of shares to outsiders.
- The level of accountability, responsibility, and participation of the shareholders is quite high.
- There is strong liability protection for the shareholders.
Disadvantages of Closed Corporation
Some of the major disadvantages are as follows:
- Many states don’t allow the incorporation of closed corporations.
- Any major decision has to be agreed upon by most of the shareholders.
- The governance of these companies is complicated and restrictive as they are governed by both bylaws and a shareholders’ agreement.
- The shares of a closed corporation have limited resale value.
- Liquidity can be a concern for a closed corporation as the shares are not traded publicly.
Key Takeaways
Some of the key takeaways of the article are:
- In a closed corporation, the shares of the company are held by a small group of people who are closely associated with the core business operations.
- Since these companies are not publicly listed on any exchange, the general public can’t invest or trade in them.
- A closed corporation enjoys more flexibility compared to any publicly-traded company because the former is free from many reporting requirements.
- One of the biggest drawbacks of this business structure is that any major business decisions have to be approved by most of the shareholders.
- By default, a closed corporation is taxed as a C corporation unless the shareholders opt for S corporation status.
Conclusion
Based on the given information, it can be said that a closed corporation is an ideal business structure for families who intend to pass the business from one generation to another, entities who don’t plan on going public, or those who want to control the number of decision-makers in the business. The decision of opting for a closed corporation should be based on various operating factors, such as taxation, regulatory requirements, etc.
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